As GDP Growth Outstrips Forecasts, Economists Scramble to Explain

What factors led to a steady growth in GDP despite demonetisation?

At 7 percent, growth in the country’s gross domestic product (GDP) has confounded economists and commentators. Most expected that activity will slow considerably between the second and third quarters of the year to reflect the impact of a shortage in currency induced by demonetisation.

The Bloomberg consensus estimate had pegged growth at 6.1 percent and few (if any) had forecast growth in the 7 percent range. No surprise then that economists are now looking for factors that explain this surprisingly positive number. Explanations differ widely with some pointing to a base effect due to the downward revision in growth for previous quarters, while others are attributing the stronger than expected growth to agriculture and higher government spending.

The Base Effect Explanation

In his report, Soumya Kanti Ghosh, chief economist at State Bank of India highlighted revisions to GDP growth data for previous quarters.

GDP growth for the first and second quarters of FY16 have been revised higher. But growth for the third quarter of FY16 was revised lower. This would have had some impact on the headline number for the third quarter of FY17, Ghosh wrote in his report.

Despite the upward revision of Q1 FY16 and Q2 FY16, GDP estimates for Q1 FY17 and Q2 FY17 have been revised upwards indicating improvement in economic activity in first half of the current fiscal. The steep downward revision of Q3 FY16 has in turn led to higher growth in Q3 FY17, thus masking the impact of demonetisation in the Q3 figures.

Soumya Kanti Ghosh, Chief Economist, State Bank of India

Sonal Varma of Nomura also thinks that the downward revision in growth for comparable quarter of last year impacted the numbers. But she throws in a few other possible explanations.

Nomura believe there could be three reasons for the upside surprise:

• A favourable base effect created by downward revision in comparable quarters
• If companies showed their cash in hand (after demonetisation) as sales, then this may be getting captured as a higher value addition in these specific sectors
• The inability of official statistics to capture the negative growth effects on the unorganised sectors

Impact On Informal Sector Not Captured?

The inability to capture informal sector data is being cited by one than one economist to explain why demonetisation has had a minimal impact on growth data.

Just like Varma of Nomura, Pranjul Bhandari at HSBC also thinks that could be one reason why GDP growth surprised to the upside.

CSO may inadvertently be exaggerating today’s growth print because it has no way to collect informal sector data over the short run, which is likely to have been hurt most by demonetisation. The rapid 8.3 percent growth in manufacturing may well be reflecting this.

Pranjul Bhandari, Chief India Economist, HSBC

Samiran Chakraborty shares that view.

The growth in the unorganised sector (which represents 21.5 percent of the manufacturing sector) is estimated using proxy indicators like IIP (Index of Industrial Production) and may undergo significant downward revision, wrote Chakraborty. “Yet as the supply of currency improves (over 60 percent of demonetised currency is already back in the system), we expect the demand situation to normalise and the disruptions in rural/SME supply chains to be repaired,” he added in his analysis of the GDP data.

Agriculture, Government Spending Support

Some economists are also citing the strong growth in agriculture and government spending, both of which supported growth during the quarter.

Government services and agriculture saw “extremely robust” growth at 12 percent and 6 percent YoY, respectively, wrote Kapil Gupta at Edelweiss Financial Services. Excluding these, private sector real activity did slowdown led by the financial services and real estate segment along with construction activity.

Shubhada Rao, chief economist at Yes Bank also highlighted this:

Excluding agriculture and public administration, Q3 FY17 GVA (Gross Value Added) growth was 5.8 percent vis-à-vis 6.4 percent in Q2 and 7.4 percent in Q1 which clearly shows loss of momentum in economic activity. Maximum impact of demonetisation is visible in the finance and real estate sector with some spillover in construction.

(This article was originally published on BloombergQuint)